This week I came across a situation where a friend was considering investing in an unregulated private placement deal. The friend is not a “qualified investor” as defined under the law and was probably actually relatively unsophisticated about investment issues. We have a mutual friend, an attorney, who was also unfamiliar with securities law and unable to offer further advice. I had only a slightly stronger background due to my years working as an SEC Registered Investment Adviser and later as a Pennsylvania Registered Investment Adviser. Yet I do not presume to be able to evaluate the merits of a private placement offering. Ignoring the tough questions on this topic can be dangerous. We’ve all read newspaper accounts of investors who lost money simply because they did not ask the most basic questions about the legality of a deal before they invested.
I decided to compile this very simple three point article as a basic response to the situation using Pennsylvania law as a background in the discussion.
1) Legal requirements.
State and federal laws control the marketing of investments. These laws primarily focus on the requirement to disclose information in writing. These same laws also allow some deals to be sold without registration. These are listed as exemptions from registration. Each of the exemptions listed under Securities Law Section 203 has specific requirements that are not addressed here.
To help businesses and investors understand the laws, the Commonwealth of Pennsylvania publishes a Compendium of laws that are periodically updated with evolving issues. Unfortunately, I conclude that it takes an attorney specifically experienced in securities law to make practical use of this information. The practical impact is that if a consumer has a question about the legality of an investment this almost always requires input from a specially trained professional or regulator. It would be naive, in my opinion, for any consumer or promoter to presume to be able to be able to make accurate legal determinations about investment laws on their own.
2) Red flags for consumers.
An investment promoter who does not appear to be conversant on the specific legal requirements of the industry, who avoids discussing the topic, or who is not forthcoming in offering the name of the firm’s attorney and accountant are all red flags. A firm that says that have never had a deal go bad is a red flag. The absence of a written memorandum of the deal or a financial statement of the promoter should immediately raise concern. The use of certain inappropriate terminology like “IRS approved” or “SEC compliant” are also signs of lack of legal compliance.
3) What to do if you have questions.
The SEC and state securities regulators have services that allow consumers to submit a question about any firm or offering. The Pennsylvania Department of Banking and Securities writes “We provide free help to anyone with a question, concern or complaint about Pennsylvania financial institutions or products. Simply call 1-800-PA-BANKS (1-800-722-2657)”. The department promises that a trained professional will respond within 24 hours. Obviously the SEC has its own investor resources and each other state has a separate phone number for consumer inquiries.